As a first time investor in the stock market, you may have heard or read about the term ‘Rights Issue of Shares’ in the news or public filings. You may not be familiar with the term, its advantages and disadvantages and impact on the shareholders? Your search ends here as we will be discussing the concept of the rights issue in great detail.
What is Rights Issue of Shares?
A rights issue of shares is basically a way through which a listed company in a stock exchange raises additional fund. It may seem similar to the Follow-on Public Offer (FPO), but there is a catch here. Here the new shares being issued are not offered to the public, instead, it is offered to the existing shareholders of the company. The shareholders have the right to subscribe the shares in proportion to their existing holdings, in a pre-defined time period.
For example, 1:2 rights issues signify that the existing shareholders of the company can purchase one extra share for every two shares already held in the Demat account. Here, a very important point to be noted that the new shares are issued at a discounted price than the current or prevailing rate in the market.
Why Does a Company Go for Rights Issue of Shares?
Companies opt for the rights issue of shares to raise funds for expansion, launching new products, improving debt to equity ratio, paying off debt or for taking over another company. It is perhaps one of the best ways to raise capital without incurring additional debt because instead of borrowing money from the banks and pay high-interest rates, it is quite a feasible option to raise funds from the existing shareholders.
Advantages of the Rights Issue of Shares
- The shares are offered to the shareholders at the discounted price to encourage them to purchase the rights issue.
- The company saves a significant amount of money, such as underwriting fees, advertisement cost and so on.
- The control of the company remains in the hands of the existing shareholders. This is because the shares are only issued to those shareholders who on the date of rights issue are the holders of the shares.
- There is an equitable distribution of the shares and the same proportion of the voting rights.
Disadvantages of the Rights Issue of Shares
- The company may not be able to raise more funds and fail to achieve their target. This may happen if the existing shareholders of the company are not too keen to invest more.
- The value of each share may get diluted if there are an increased number of shares issued.
- If a well-established company is going for the rights issue of the shares, then it goes on to create a negative market sentiment. It is assumed that the company is struggling to run its business operations smoothly.
Types of Rights Issue of Shares
There are two main types of rights issue of shares, which are as follows:
- Renounceable Rights Issue: Here, an existing shareholder of the company has the right to transfer his/her right to subscribe rights issue of shares to anyone who may not be even shareholder of the company.
- Non-Renounceable Rights Issue: The existing shareholders do not have the right to transfer his/her right to subscribe rights issue of shares to anyone. Here, the shareholder only has two options available, either to skip or purchase the shares.
Procedure for Rights Issue of Shares
There is a proper process that is followed by the company for the rights issue of shares, which is mentioned below:
- A board meeting is called for the purpose of the rights issue of shares.
- After the approval of the board of directors of the company, an offer letter for the rights issue of shares, which also includes the right for renunciation option, is sent to the existing shareholders of the company. It must be noted that the letter must reach the shareholders around three days before the date of the rights issue.
- The company must receive the letters of rejection or acceptance from the shareholders.
- A board meeting is called again to approve the allotment of the shares to the shareholders who have shown keen interest to subscribe to the rights issue of shares.
- A share certificate is issued to the shareholders
Should You Go For the Rights Issues of Shares?
It is important that the investors must not get tempted to the discounted rates at which the right shares are issued by the company. They must do their homework well in advance and must only invest if they are completely sure that the funds raised from the rights issue will be used for the betterment of the company. After all, it does not make any sense at all to invest in the rights issue shares of the company with a bad performance and lose your hard-earned money. Hence, CAUTION is advised before you make up your mind to go for the rights issue of shares.